The Rise of Qardh

I wrote earlier in July 2014 about re-branding Wadiah following discussions the industry had with BNM. In that meeting, the key take-away was that there is an intention to re-brand Wadiah into Qard, to which the industry reacted negatively as Wadiah has always been used for short-term deposit structures where discretionary hibah “gifts” are given to depositors. BNM contention was that Wadiah do not meet the practice of the Bank where Wadiah was supposed to be taken as “safe-keeping based on trusteeship” (Wadiah Yad Amanah) or “safe-keeping with guarantee” (Wadiah Yad Dhamanah). The main argument was the under the Wadiah structure, the ownership of the fungible asset remains with the customer and the Bank has not obtained sufficient consent from the customer to utilise their funds, specifically for Wadiah Yad Dhamanah.

Wadiah 2014

The solution for the above conundrum, offered by BNM, is therefore, migrate to Qard-based products, where by virtue of it being a loan from the customer to the Bank, the ownership is transferred to the Bank allowing the Bank to utilise it as it pleases, while guaranteeing the loan amount upon demand (you have to repay back the loan).

As mentioned in my earlier writing, some industry players has clear reservation to convert Wadiah to Qard, seeing that the various guidelines are coming thick and fast to comply with requirements under Investment Accounts. Handling another major change in regulations will just hamper the industry’s growth.

Now, 16 January 2015. The revised Concept Paper for Wadiah was issued. We are given 1 month to respond with our feedback.

Wadiah CP

The biggest shock is that the paper has re-defined Wadiah as only Wadiah Yad Amanah i.e. safe-keeping trusteeship. There was NO mention of the contract that most Banks are currently using for Current Account / Savings Account i.e. Wadiah Yad Dhamanah (safe-keeping with guarantee) which allowed the Banks to utilise the funds for Bank’s activities. What this removal of definition means:

  1. The Bank takes Customer Assets and safely keeps as Wadiah in the Bank until a request to withdraw the Asset is made by the customer. The Bank must return the initial Asset to the customer upon request, with no obligation to provide any other benefits.
  2. The Bank does not have the right to utilise this Asset under Wadiah anymore #.
  3. If the Bank intents to utilise the money for purpose of generating returns, then the rules of Qard must apply i.e. for the Bank to obtain the right to utilise the money, the ownership of the money must be transferred to the Bank i.e. the customer no longer has financial and ownership rights when the funds are utilised by the Bank to generate returns. It is a loan by the customer to the Bank. As owner of the money now, the Bank has full rights to the returns. The Bank has no obligations to the customer except of return of the loan on demand. Discretionary hibah “gift” may be given, but questions may soon come on its validity when it is deemed as “Urf” (customary, no longer discretionary).

# Previously under the rules of Wadiah Yad Dhamanah, if the Bank intends to utilise fungible Assets deposited by customers to Banks such as money, sufficient consent must be obtained before the Bank utilise the money for other purpose (including for generating returns). In reality, this consent is really lacking especially for a daily product such as Current Account or Savings Account, resulting in insufficient rights to use customer’s fund to generate returns. The Banks are also not allowed to agree the returns up-front for the use of the money yet circumvents this by publishing historical rates of returns instead. This “historical return” soon was construed as non-discretionary and deemed as returns that is treated as Urf’. Therefore, Wadiah Yad Dhamanah was totally removed by BNM as a viable Islamic Banking concept, and now to be replaced by Qard (where ownership of funds are wholly transferred to the Bank).

Utilisation of Money

In any circumstances, Banks do utilise the Customers’ money for banking activities, including investments. If we retain Wadiah under this new BNM definition, then it will greatly impair Islamic Banks if we are not able to utilise collected funds for generating profit. The Wadiah moving forward will only apply for Safe Deposit Box services where the Bank can charge a minimal fee for safe-keeping services. Trying to apply it to anything else will be a challenge.

Wadiah 2015

The Qard guidelines needs to come sooner than later. At least the Exposure Draft or the Concept Paper needs to be available for discussion and for Banks to assess the Impact going forward. The impact by IFSA 2013 will be fully felt right after the coming months of June 2015, and this new regulation will further add to the re-branding of Islamic Banking currently taking place in Malaysia.

Rebranding Wadiah

A few days ago we had an interesting session with the Malaysian regulators. The agenda listed as “Discussion on the Wadiah Concept Paper”, a paper which was issued in December 2013, and had caused quite a stir in the industry. The main content of that paper was the treatment of Hibah (gift) payments on balances maintained in the Wadiah accounts, and the underlying rules of Wadiah.

For clarity, Wadiah (safe keeping) contract is used in Malaysia for savings / transactional type of accounts. The intention is that the customer enters into a relationship with the bank as a Wadi’ (custodian of deposit) and Mudi’ (owner of capital / depositor). The mandate is purely on a custodial basis. In practice, the customer places funds with the bank for the purpose of safe keeping, therefore the bank must become just a custodian of the depositors money. However, it is unlikely that the bank just receives the funds and not utilise it for an economic activity.

Because of this use of funds by the bank, Malaysian scholars view it is only fair as a good banking practice, that some discretionary returns may be given to customer for the use of the customer’s funds. This returns, while not promised up-front, has over a period of time, become customary (Urf’) in its execution and distribution. The whole arrangement is known as Wadiah Yad Dhamanah (safe custody with guarantee). As I understand it, only Malaysia offers this contract for Savings and/or Current Account products in the world.

In all other geographies, the Current Account and/or Savings Account commonly use either the Qard (interest-free loan) contract, or the Mudharaba (profit sharing entrepreneurship) contract.

Wadiah vs Qard Update

All these years, we are of the view that there is a identifiable difference between Wadiah and Qard. Under Qard, the arrangement is where the customer provides the bank with a loan i.e. the deposit amount which must be returned to the customer upon demand. While Wadiah also operates the same way, the only difference is that Wadiah allows for the granting of discretionary Hibah arising from the use of the customer’s funds.

So it was a small surprise to note that in the Wadiah Concept paper issued in December last year, there is a specific mention that while there is a differentiation in relationship for Wadiah and Qard, the rules of Qard will also apply to Wadiah. The issue of discretionary Hibah is also raised that if the Hibah is paid consistently, it becomes customary (Urf’) and therefore can no longer be viewed as “discretionary”.

That is why I was surprised that the meeting a few days ago asked this question; “What are the views of Islamic Banks if the Wadiah contract is now demised and replaced by Qard, while the practice of paying discretionary Hibah is retained even for Qard? Would the banks be open to this “change in name only” while the principles of the product remains the same?”

My concerns with this direction are:

  1. Such allowance to continue to provide Hibah on a Wadiah (in name only) will only be temporary and will eventually turn to what is practiced in the middle east i.e. no payment of Hibah.
  2. Confusion may ensue as there will be two separate rules governing a Qard i.e. different rules in Malaysia and what is being practised elsewhere. This opens up the Malaysian-version of Qard to criticism and I believe, sooner than later, consolidation of practice and understanding will happen.
  3. The investment effort to be spent into Wadiah products will now no longer make sense. Eventually, Wadiah will cease to be a savings-and-deposit-building proposition for the Bank. It will revert into a basic, transactional and low balance proposition, which might not be attractive for Banks to further invest into. Other options will now take prominence.

Will Wadiah also survive this re-branding of Islamic Banking in general in Malaysia? We are expecting some changes to surface this end of year and it will put further pressure on the industry which is already reeling from the existing changes that was introduced. From where I am sitting, it seems that soon, Wadiah will be re-branded into a version of Qard, as a pre-cursor of eventually becoming “pure” Qard.

Looks like another one will soon bite the dust.

Goods and Services Tax on Islamic Products

Goods Services Tax (GST)  will be one of the hot topics for the years to come in Malaysia, when the GST finally comes into place in 2015 to replace the Services Tax. Many arguments have been made on both side of the political divide but the reality is that GST will be implemented and have a huge impact on how services and goods are being priced.

A quick look at the GST finds that Sharia compliant banking, while having all its contracts requiring underlying transactions, asset ownership and movement of actual goods, the impact that the GST may have on Islamic contract will remain similar to what impacts a conventional banking product. There is not expected to have a “worse-off” effect on Sharia compliant banking.

GST

It is heartening to see that Customs has made an effort to understand the various Islamic banking contracts and how it works, and identify potential transactional points where a GST may be imposed. I find the attached document (GST Industry Guide – Islamic Banking (As at 1 November 2013)) extremely useful summary of the intended GST implementation on Sharia banking contracts.

10 particular contracts have been identified and the GST points are outlined accordingly.

Please Click Here

Banking with Non-Islamic Banking Institutions

I remember many years ago being in an interesting conversation with my Bank’s Sharia Advisor on the topic of accepting funds from an organisation which deals with non-sharia compliant activities. What was the view on taking funds you know were generated from doubtful sources. Whether it is reputationally acceptable to take in deposits from customers involved in gambling, usury and prohibited activities.

Some institutions were reluctant to take in these institutions as customers, even though they were huge, cash-rich corporations. The worry is on the perception that we Islamic bankers are supporting them via our activities, that they benefit from their patronage of our bank. Some even said that taking their “dirty” money and putting it into our pool of “clean” funds will result in co-mingling of the funds. The fact that we provide services to non-Sharia compliant institutions, bothered some quarters.

My advisor said it simply. Why not we take their funds? If you don’t take it, where would it then go? It will go back into the conventional system, generate more money, providing more funds to allow the conventional banks to loan the money to more customers. This will grow the conventional pool of funds, increase the loans portfolio in interest-lending and further strengthen a conventional banks profit. Islamic banks will then have to grow organically, fighting for the piece of pie that’s available against huge conventional banking giants.

Take the money. Invest in Islamic industry. Grow our books. Invest in Sharia-compliant manner. And provide good returns to the conventional depositors and investors. Change their mind by proving that Islamic banking is universal. That the model is viable. Innovative, competitive and fair. Provide the alternative for a feasible banking structure. Give da’wah and awareness on Islamic banking and its underlying principles. Prove we can co-exist side by side.

Probably one of the wisest things I have heard. Although not many will have the same sentiment to this. So it is ok to agree to disagree.
Investment by Conventional Banks
But what if it is the other way around? Can an Islamic Bank invest or place their deposits with a conventional banking counterpart, who deals in non-compliant activities? The answer is obviously a NO. Depositors funds, taken under a Sharia-compliant contract, should be used for sharia approved activities only. Morally, it is wrong to paint a picture that the Bank is Sharia-compliant but is actually a deposit collection arm of the Non-Sharia-compliant bank. It’s misleading and damaging to the Islamic bank to have this reputation.

Investment in Conventional Bank

Yet, is there a solution to this argument? What if we still deposit funds into a conventional bank, yet with a strict condition put on the use of these fund for Sharia compliant investments only? Will that be enough to allay the concerns? If it does, what is the relationship that will be between us and a conventional bank? Can we appoint a conventional bank as our “Wakeel” to execute Sharia compliant transactions?

Personally, I do have reservations on this. Conventional banks do not have any compulsion on the execution of a transaction whether Islamic or otherwise. They do not bother about its use or matters such as sequencing or ownership. Their law is civil law, and is dependent on the legal documentation. This, then, is merely passing of money to a conventional entity, when our depositors have trusted us to invest in Sharia compliant activities. Can we be assured that the monies passed over be used according to our requirements? How do we get this assurance?

What is your Bank doing? Can this be a possible model?

Exposure Draft : Wadiah

Image

One of the panic buttons we are pressing now is the new Wadiah Exposure Draft (ED). As a rule, Wadiah is a “safe-keeping with guarantee” arrangement, where a Bank agrees to take on-board customers deposits as a loan (Qardh). And in the rules of loan under Islamic Banking, a loan must be returned on the same amount when required; any amount above and beyond the loan amount, if put as a condition at the start or during of the deposit placement, may be construed as “Riba”. If the Bank utilises the deposits for any business activities, the Bank is given the discretion to award “Hibah” or gift payments allocated based on the balance outstanding.

With the introduction of the IFSA and the requirements that Malaysian Banks comply with the Investment Account Framework  if Mudarabah continued to be offered to Customers, the common wisdom is to migrate lock-stock-and-barrel into a Wadiah account. In my earlier writings, I already mentioned that to comply with the Investment Account Framework, a massive shift in thinking, processes, and management is required. Therefore to convert into a Wadiah structure may not be the ideal solution, but it will provide an “easier” route towards retaining Customers’ deposit.

Wadiah ED

However, in this chess game between the Islamic Banks and Bank Negara Malaysia (BNM), the new ED is introduced on Wadiah has effectively further tied the hands of the industry players. BNM had anticipated the industry intentions to move the Mudarabah structure into Wadiah, and promptly outlined further restrictions on Wadiah itself. The industry is now caught between a cold and hard place; stay with Mudarabah and comply with Investment Account Framework, or migrate into Wadiah and comply with the new Wadiah Guidelines.

Wadiah Concept Paper

As we know, Wadiah also puts significant limitation on the marketing of returns and benefits to customers for their deposits. BNM took this a step further; to emphasize that returns on a Wadiah account should always be discretionary, as Wadiah is now seen as a loan. The impact comes in several clauses in the Exposure Draft:

  1. Wadiah Yad Dhammanh is considered similar in nature to Qard. Therefore the rules of Qardh should also apply to Wadiah.
  2. A majority of customers should not be getting a return on the deposit under Qardh. Generally this is saying that out of 100 customers, only 49% of customer will be given a “gift” on their deposits
  3. The payment of the discretionary “gift” should not be construed as regular or common business practice (Urf’ Tijari) else it will imply that the “gift” is a constant return to the customer. Historical performance can be shown to customers.
  4. Any benefits, monetary or otherwise, deriving directly from the placement in the Wadiah account may be construed as “Riba” as well.
  5. Any benefits includes scenarios where should the Wadiah account be opened as part of a financing facility, and benefits enjoyed in the financing facility from amounts available in the Wadiah account (for example a rebate structure to off-set an obligation), shall be construed as riba’ as well.

My main question is; now that Mudharabah is turned into a pure investment account, and Wadiah carrying so many restrictions, what other solutions are there? It cannot be that BNM only expects us to comply but do not help with a viable solution on these restrictions. Yes we are looking at the Commodity Murabahah structures, but operationally this will be a challenge for the Banks to control the cost of commodity trade.

Wadiah ED

And how do we define majority, then? The system must now be enhanced to determine who gets the discretionary “gifts” based on which formula. Even if they qualify for the discretionary “gifts”, to award them on a regular basis will also lead to it be construed as “Urf Tijari”, where consistent payment of Hibah will imply a similar future returns. How do we define this “non-majority” of Customers whom qualifies for Hibah but do not get regular awards of Hibah? What system logic can we build and will what we build be acceptable to Sharia? More importantly, would the customer even accept such “discretionary” practice?

Now that BNM has issued a new Concept Paper on Shariah Requirements, Optional Practices and Operational Requirements of Mudarabah today, we get a somewhat watered-down requirements to Mudarabah products. I have read it and saw that under this new Framework, the Mudarabah structure remains viable as it is, with enhancements needed for documentation and disclosures. Manageable and workable. The next steps must be; if we were to stick with Mudarabah, which Framework will take precedent. Mudarabah is an Investment structure. So, would we follow the Mudarabah Framework, or to comply with the Investment Account Framework? Both Frameworks makes reference to each other; yet one is stricter than the other.

I am putting all my hopes on the new Framework. That will give me some leeway of having both Wadiah structure and a viable Mudarabah structure (not based on the Investment Account Framework). This is definitely the light at the end of the tunnel. But as usual, indications are to take the “stricter” guidelines into account, rather than keeping hope for an easier implementation.